What is Trade Finance? Why is it Important for the World Economy?

Trade finance refers to the financing of services or goods in a transaction or a trade. This is done between a supplier to the end-user. It accounts for around 3 percent of the global trade. Its annual worth comes to around $3 Trillion. However, trade finance is an umbrella term. It denotes a wide range of financial practices followed by an exporter or importer.

These financial exchanges may include but are not limited to the following list:

  1. Supply chain finance
  2. Structured commodity finance
  3. Invoice finance – factoring and discounting
  4. Stock finance
  5. Purchase order finance
  6. Letters of credit or LCs
  7. Bonds and guarantees

Both the term export finance and import finance are interchangeably used with trade finance. However, the latter term incorporates multiple components mentioned above.

How does trade finance benefit a business?

Trade finance ensures the enhancement of a business by securing capital needed to purchase stocks and goods. Managing cash flow, purchasing the latest tools, and having working capital are three significant aspects to ensure the success of any business.

You may consider trade finance as a weapon that can unlock capital from any company’s existing stock. It contributes to the entire trade circle of the company.

The trade financing facility enables businesses to offer attractive terms to both the customers and suppliers. Thereby your business can win a competitive edge in the market. The reason is that trade finance reduces the payment gaps in any trade circle. It is advantageous for the sustainable supply chain relationship and enhancement.

Other advantages of trade finance 

  1. Trade finance helps to use a short to medium range of working capital for underlying services and products. It helps to import and export the capital in terms of security and collateral. Further, this can increase any company’s potential to earn revenue. And also, to get a higher margin in the market.
  2. It enables companies to request for high volumes of stocks or large orders to the suppliers. This leads to bulk discounts and scales profit margin.
  3. Trade finance also helps in strengthening the bond between the sellers and the buyers. It enables a company to be highly competitive in the market.
  4. It helps to manage the supply chain which is the most critical for any business. Trade and supply chain management helps in easing out liquidity gaps and cash constraints for everyone involved in a business. This may include providers or employees, third parties, customers, and suppliers. Earlier payments also help in mitigating any risk for the suppliers.

A few important notes

There are some misconceptions about trade finance. Here we are to bust them one by one.

It’s important to know that trade financing stresses more on the trade than any underlying borrower. This means that it is governed merely by a balance sheet. Hence, small businesses with a poor balance sheet may use trade finance to improve their condition. Despite having a weak balance sheet, these businesses can deal with stronger end consumers and large volumes of services and products.

Due to the risk mitigation issues that revolve around trade finance instruments and lending. It opens an all-new potential for the suppliers. And a diverse array of supply networks enhances the efficiency as well as the healthy completion in the supply chains and marketing. 

Companies can also become able to mitigate business risks by utilizing proper trade finance structures. Late payments from excess stocks, bad debts, and debtors and demanding creditors produce an adverse impact on businesses. External financing or repetitive credit facilities can ease out the pressure.

However, it’s important to find a reliable trade finance management team that can help you deal with all the issues.  

Strategic financial management

Trade finance seems to be a miracle for the advancement of a business but it is strategic financial management. It is the lifeblood of many of the cross-border business deals. Exporters need the due payment for the services and goods they are selling out. On the other hand, importers require a guarantee. This means they agree to the delivery and status of the service or purchased goods. Basically, trade finance creates the opportunities for everyone – it is not partial to either the importer or the exporter.

Naturally, it ensures that the entire trading business across the world runs smoothly. Now that you have taken a decision to create your small business or lift the existing business to an enterprise-level, you must need a solid understanding of trade finance. It enables you to get access to a wide range of products. Further, it helps to expand your audience reach, establish strong brand authority in your business vertical, and distribute your products or services abroad.

For instance, imagine yourself as a textile owner from Rangoon or a Burmese entrepreneur. It’s difficult for them to get the exposure required in any business.

The first challenge for them is to get financial support

The local banks are unable to provide an extensive financial backup and you need to pay huge interest. This will impact your revenue adversely. The second issue is that of contemporary regulations. These are outdated and restrict useful activities such as getting cash in advance prior to selling out the products. Large firms can afford these but new start-ups often face challenges in the face of such adversaries. In fact, according to several studies, unregulated financial management is a potential issue to restrict small businesses or local start-ups from flourishing. Usually, start-ups start with a dire passion to do something innovative and extraordinary. However, in the face of such challenges, entrepreneurs prefer to pursue a different passion.

Trade finance lends a helping hand in dealing with such a crisis. This mechanism merges the gap between a product’s shipment, arrival in the market, and receiving the payment. Timely payment, deterioration or even the loss of valuable products and services, and a fixed exchange rate always come in handy.

Conclusion 

Trade finance plays a major role in fostering businesses and advancing the entire world economy. In other words, every small business contributes its part in driving the economy and trade finance is the core to it.

To learn more about the trade finance services we offer, visit our expertise page!

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Christina Baggins
AMB Content Writer
Christina is a researcher and writer at Agro Merchant Bank and specializes in educating suppliers & brokers in essential trade knowledge.
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